This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.
spk00: Good morning, and thank you for joining the Badger Meter fourth quarter and full year 2021 earnings conference call. On the call with me today are Ken Bockhorst, Chairman, President, and Chief Executive Officer, and Bob Brockledge, Chief Financial Officer. The earnings release and related slide presentation are available on our website. Quickly, I'll cover the safe harbor, reminding you that any forward-looking statements made during this call are subject to various risks and uncertainties. the most important of which are outlined in our press release and SEC filings. On today's call, we will refer to certain non-GAAP financial metrics. Our earnings slides provide a reconciliation of the GAAP to non-GAAP financial metrics used. Finally, during this call, we will refer to core results for various financial metrics, for example, core utility water sales. Core means the designated financial metric excluding the year-over-year impact of the USCAN and ATI acquisitions. We believe this reference point is important for year-over-year comparability. With that, I'll turn the call over to Ken.
spk07: Thanks, Karen, and thank you for joining our fourth quarter earnings call. Our strong fourth quarter results capped off a record year for BadgerMeter with sales surpassing $500 million for the first time in our history. We executed well on many fronts this past year, including successfully integrating two highly complimentary water quality acquisitions, adeptly managing ever-changing supply chain challenges and the lingering impacts of the pandemic, and implementing value-based pricing and other actions to offset inflationary pressures. I want to thank the Badger Meter team globally for their tremendous execution and focus on the customer. I'll recap the year and talk about the current environment and our market outlook later in the call. But for now, let me turn the call over to Bob to go through the details of the quarter.
spk02: Thanks, Ken, and good morning, everyone. Turning to slide four, our total sales for the fourth quarter were $135.7 million, an increase of 20.8% over the $112.3 million in the same period last year. Total utility water product line sales increased 23.4%. Acquisition-related water quality sales totaled $11.1 million in the quarter, compared to 2.4 million last year, which included only two months of SCAN results. As a reminder, as we move into 2022, we will anniversary the acquisitions in our reporting of results. Excluding the year over year benefit of the water quality acquisitions, core utility water revenues increased 14.4% as continued strong order demand and recovering production output was modestly offset by intermittent supply chain disruptions that continued to restrict backlog conversion. We experienced growth in cellular radio and beacon software as a service sales, and we continue to realize the benefit from strategic and value-based pricing actions. Strong order momentum continued in the fourth quarter of 2021, and we exited the year with yet another record high core backlog. Sales for the flow instrumentation product line increased 8.9% year over year, as steady demand trends across the majority of global end markets and applications was partially offset by supply constraints which limited production. We were very pleased with the margin performance in the quarter in light of widespread inflation and the dynamic supply chain impact on our manufacturing operations. Starting with gross margins, we increased gross margin dollars by $10.8 million year over year. As a percent of sales, gross margins improved 120 basis points to 40.4% from 39.2%. Margins benefited from favorable acquisition mix, as well as the higher volumes and positive product sales mix, namely higher radio and SAS revenues. In addition, the prior year included a non-recurring discrete network sunset provision. These factors combined more than offset the cost headwinds experienced across purchase components, including brass and electronics, as well as increased freight and logistics costs year over year. Looking forward, we anticipate continued inflation in 2022 that may constrain margins, with some comparative easing as the year progresses and as 2021 cost increases become anniversary. SEA expenses in the fourth quarter were $32 million, generally consistent with the quarterly absolute dollar spend throughout 2021. As a percent of sales, SEA was 23.6% in the quarter, a 50 basis point improvement year over year, and a 110 basis point improvement sequentially due to the higher sales. We expect SEA spend in 2022 to increase as a result of inflation, variable compensation, and ongoing growth investments, yet we continue to endeavor to improve SEA leverage as a percent of sales. As a result of the above, overall operating profit margin was 16.8%, a 170 basis point improvement compared to 15.1% in the prior year quarter. The income tax provision in the fourth quarter of 2021 was 24.5%. an increase over the prior year's 22.6% and within our normalized rate in the mid-20% range. In summary, EPS was 59 cents in the fourth quarter of 2021, an increase of 31% from the prior year's EPS of 45 cents. Working capital as a percent of sales was 24.5%, a decrease of 110 basis points compared to the prior quarter end. As expected, the temporary elevation in primary working capital we experienced last quarter did return to more normalized levels as we finished out the year. Free cash flow of $26.2 million was higher than the prior year's $12.7 million, the result of higher earnings and working capital recovery between years. For the full year, free cash flow was $80.8 million, and free cash flow conversion of net earnings was 133%. While moderated from the unsustainably high levels of the past two years, which reflect the structural benefit of low-hanging fruit efforts in the areas of primary working capital, this conversion rate exceeds our annual target of greater than 100% free cash flow conversion. With that, I'll turn the call back over to Ken.
spk07: Thanks, Bob. Turning to slide five, I wanted to provide a year-one assessment of our water quality acquisition integration efforts. In short, I'm extremely pleased with our progress to date. As a reminder, the strategic rationale for these tuck-in acquisitions was to add real-time water quality parameters to BadgerMeter's core flow measurement, pressure, and temperature sensing capabilities, and to enhance the scope of actionable data for utilities to improve operating efficiency and resiliency, and for industrial customers to monitor both process and discharge water. From a financial performance standpoint, at acquisition, the combined acquired annual sales of SCAN and ATI were approximately $37 million, with EBITDA margins in the mid-teens. We finished 2021 with a combined $43 million in sales, representing a pro forma increase of 16%. EBITDA margins expanded modestly, and working capital as a percent of sales improved. Most importantly, from an integration standpoint, customer discussions confirmed the growing need and acceptance of online, low maintenance, and reagent-free solutions for real-time water quality monitoring. These distributed solutions will be transformational for utilities, wastewater, and industrial customers. We're executing on multiple avenues to drive growth synergies. For example, optimizing the complementary product offerings of both electrochemical and optical sensors across water quality parameters. Leveraging geographic strengths, for example, the ATI relationships with UK water utilities. We've cross-trained and educated sales personnel to effectively sell throughout the water ecosystem, including water utilities, wastewater treatment, and industrial water applications. We're actively working to advance our radio communications to capture the additional data parameters and augmenting our beacon and ion water solutions to provide the digital, holistic view of the water network. I'm thrilled with the quality and collaboration of the SCAN and ATI teams who share our values, commitment to innovation, and passion for sustainability. Creating a tailorable, scalable digital solution will take time and investment, but we're well-positioned to realize the long-term growth synergies we anticipated. In summary, here on slide six, our performance through the pandemic in 2020 and widespread supply and inflationary challenges in 2021 demonstrates the resilience of our business model and our global team. We delivered core utility water revenue growth of 9,000 in 2021, building on the 4% growth in 2020. We further expanded our SAS revenue as a percent of consolidated sales to over 5%, even with a significant increase in instrument sales. Our strong execution served to build on our track record of improved margins and cash flow. And as I just discussed, we successfully executed and integrated two strategic acquisitions. As we begin fiscal 2022, we're optimistic about our opportunities for growth. Strong order momentum continued throughout the fourth quarter, and even with recovering production levels, our backlog again reached another record high, which bodes well for our expectations moving forward. As always, we could experience variability in the cadence of sales throughout the year. Our robust order activity is evidence of our strong execution and the structural underlying demand for digital water solutions to monitor, manage, and support operational efficiencies and sustainability throughout the water distribution system. We're uniquely positioned with a full line of smart water offerings, including market leading cellular communications and software. In addition, despite the array of macro challenges, we are winning through innovation and exceptional support of our customers. We do anticipate that shortages will persist for a variety of components and that we will continue to see inflationary cost pressures as well as lingering effects from the pandemic. While we work to mitigate the impact of these near-term challenges, our priorities will be focused on executing our growth strategies and delivering value for shareholders. We were proud to be named for the first time as one of Newsweek's most responsible companies. In 2022, we will release our biennial sustainability report covering 2020 and 2021 activities, highlighting our progress across the most material ESG risks and opportunities, including employee engagement, safety, reducing greenhouse gas emissions, fostering our culture of inclusion, and of course, promoting water conservation and quality. To close out our prepared remarks, I want to again recognize our team for their commitment to serving customers and for working to preserve and protect the world's most precious resource. With that, operator, please open the line for questions.
spk06: Thank you very much. If you'd like to ask a question, please press star followed by 1 in your telephone keypad. And if you change your mind, please press star followed by 2. Our first question on the line comes in from Andrew Escalier of Berenberg Capital Markets. Andrew, your line is open. Please go ahead with your question. Thank you very much.
spk04: Good morning, guys. So, you know, you put together a pretty good year-end quarter, especially around margins. And, you know, you presumably may have been through the worst. I'm curious what your thoughts are on that comment, if things have gotten worse since Q3 for you guys. Clearly, you're navigating it well, but With your visibility into next year at this point with record backlog, how do you see those margins evolving? Because if you are through the worst and you guys are clearly handling all the supply chain challenges and inflation very well, then you must have some confidence that the gross margin levels are sustainable from here at these higher levels.
spk07: Andrew this is Ken yeah yeah thanks for thanks for the question yeah we're obviously we're really proud of how the quarter and the year turned out both from a growth and a margin point of view clearly the inflationary environment has been difficult and it continues to be somewhat uncertain but what we are confident in is that the solutions that we're providing to our customers are valued by them and we have a great process in place to continue to to manage throughout this period with what we view as really strong performance. In terms of how we see that playing out, I'll let Bob talk about what he thinks from an inflationary point of view, but extremely confident that we'll be able to continue to monitor or perform very well regardless of what comes.
spk02: Andrew, I think the only thing I'd add to that, you know, clearly 2021 was a tale of two halves as it relates to price-cost dynamics. Clearly we started the first part of the year with more favorable price-cost dynamics as we had implemented some value-based pricing actions in late 2020, arriving into 2021. Copper at the same time was still rising in the first half of 2021, albeit capped out sort of mid-year. and stayed relatively steady thereafter. I would just say our price-cost dynamics became more neutral to negative in the back half of the year. And I think when you contemplate that record backlog, while we've made pricing actions here in the very recent past, actually in the fourth quarter we implemented a list price increase, which will take some time to work its way into the P&L. We do have this elevated backlog that still is not subject to those price increases. And so there's a bit of needing to lap that and needing to lap the cost increases in 2021 that will impact sort of the year-over-year comparisons. We've talked historically in the past about a tightening of our gross margin performance from historically 36% to 40%, then a tighter band to 38% to 40%. I think we're more comfortable with an even tighter band than that. I think the hesitation of migrating that figure north is just those current short-term items that I just discussed.
spk04: Okay, very helpful. And another question I have specifically on the water utility sales side, you know, really impressive organic growth there this quarter and for the year in general. You know, and if you're heading into the year with some record backlog, so how do we think about you know, concerns around, was this sort of a pull forward grab? Um, and this is sort of like a, maybe, maybe you got over earned for a period of time and then things are going to reverse in the mean, or, you know, in that record backlog, do you, is there something that gives you confidence you can grow at a higher than historical growth rate maybe for the foreseeable future?
spk07: Yeah. So, uh, so first off, um, You know, as we think about the macro drivers for the utility space, and particularly AMI Digital Solutions, the macro drivers were strong going into COVID. And in 2020, we grew the utility sales 4%. This year, we grew sales 9%. Could have been more without some of the supply chain dynamics. And we absolutely feel confident that those macro drivers now with aging or, frankly, even Very difficult. Their non-existent workforce is even a stronger driver now than it was before. Aging infrastructure didn't get any younger, so that's still an issue. Replacement business. So we feel very confident about the direction of the market and our position to capture at least our fair share of a really strong market.
spk06: Thank you. The next question on the line comes from Nathan Jones of Stifel. Nathan, your line is open. Please go ahead.
spk01: Good morning, everyone. Morning, Nathan.
spk03: Hi, Nathan. I wanted to just start off with a question on the backlog. You know, you guys haven't historically reported backlog. I know you've been reporting it because it's elevated due to the supply chain challenges. What is your current view for the timeframe for you to be able to work that backlog back down to a more normal level? Are the supply chain challenges likely to continue to see that backlog build? Do you think that you're in a position now where either you've learned to deal with it well enough that it can stay flat or you can begin to start working it down? Just how you're thinking about getting that back into a more normalized level?
spk07: Yeah, it's interesting. As you point out, we haven't talked about it before, and frankly, I didn't expect to be talking about it still, but we just still find it relevant to point it out. We won't always talk about backlog, but it's got a long tail on it. Our customers, we're working very closely with them on making sure that we're filling all the most important demands. There may be some aspect of pull forward to Andrew's question before, but that really isn't the main driver in the backlog being elevated. I expect that it will be elevated for quite some time. We'll manage through it effectively, but this isn't going to be a situation where we're back to a normalized backlog in Q1 or Q2 or maybe even Q3. But we won't talk about it forever because at some point, the way that we see supply playing out this year is there's still going to be challenges in the first half of the year. We're certainly better off today than we were six months ago. But the first half of the year we view will be more challenging than the second half. So probably see more recovery in the second half of the year than the first. That's helpful. Thanks.
spk03: The second one I wanted to go on was balance sheet capital deployment. You know, you've got 87 million in cash, no debt. You could probably comfortably deploy 250 million in capital today and cash generated off the dividends, about $50 million annually. Can you just talk about the plans to put that capital to work to generate value for shareholders and what the most likely outlet to get a reasonable amount of leverage on the balance sheet?
spk07: Yeah, sure. So our capital allocation priorities will remain the same. So first is continuing to invest in our core R&D services, including software. I talked during the prepared remarks about continuing to invest in software initiatives to bring more water quality parameters and more use cases to our utilities and their end users. Investing in new product development. So that's still number one. Number two, we've increased dividends now for 29 consecutive years and we fully expect to continue to increase dividends annually. And then the third one is to do more acquisitions like SCAN and ATI. We are definitely looking constantly for strategic tuck-in technology deals to further advance our strategies around being smart metering, water quality, and software. So we have a very interesting funnel of targets that we're always looking at. We just have a very disciplined approach to doing it. So thrilled about the capacity that we've now built and expecting to find more quality companies like ATI and SCAN in the future.
spk03: Are there enough out there to do that? I mean, internal investments, new product development and increasing the dividends is not going to be sufficient to put capital to work to the level that you have available on the balance sheet. And you would have to do quite a fair number of SCAN and ATI kind of investments to move that capital off the balance sheet and put it to work for shareholders. Are there enough out there for you to do on that front?
spk07: Sounds like you're implying that we've created the first class problem.
spk03: That's a very high class problem.
spk07: Yeah, so there's definitely a lot of targets out there. There's a lot of things that we're working at, but you accurately point out a challenge that we do see. There's not an overabundance of targets available, but we continue to work diligently and we feel confident in our ability to do this, maybe not at the pace that... that some would expect, but we have a disciplined process we follow, and we'll be successful when we do it.
spk03: Okay, thanks for taking my questions, guys.
spk07: Sure.
spk06: From Mason, from Baird, you have the next question. Please go ahead with your question.
spk01: Yes, good morning, and nice finish to the year. Ken, a question... Regarding a comment you made in your press release, you talked about, just speaking about the industry, you talked about customer requirements to enhance operational efficiency, security, and awareness. And I'm just curious, you know, over the last year, has there been anything that has changed, you know, on the requirement side? It hasn't been to say mandate, but, you know, there were some security events we've seen. I'm just curious if there's anything that's evolved over the last 12 months that you can point to.
spk07: I would say nothing has evolved from a regulatory point of view, but just from a practicality point of view. From an efficiency point, fewer laborers and employees are costing more than they did before, so that's only pronounced. In terms of cybersecurity and awareness, you can't read any story online without hearing people being concerned about that and the water industry. definitely a growing drumbeat of interest in some of these other digital aspects of the business that makes us so excited about our software offering and what we can continue to build to fill those gaps because they certainly are trends that are going to pick up in Steam.
spk01: I see. Okay. Just also, you know, a question in referencing the fourth quarter performance, revenue performance. I know that you have been downplaying the significance of seasonality in your business. It's become more muted over time. But I'm just curious, as you think about the supply chain as it is and your backlog, is the fourth quarter, is that a representative jumping off point as we go into 2022 in terms of what can be delivered? I'm not sure if there was anything unusual in there. You mentioned growth in cellular radios and beacon. I didn't hear anything about mechanical meter growth. But just some thoughts there in terms of how we flow into 2022 off the fourth quarter.
spk02: Yeah, I would say I know there's been some historic perspective on seasonality. As you mentioned, we've downplayed that over the last several years. So I don't see market change quarter to quarter or Q3 to Q4, Q4 to Q1. So while I'll stop short of saying take Q4 and make that your number for Q1, I don't think there's a high degree of seasonality to contemplate. There's no real outliers.
spk01: Is there, Bob, you talked about logistical challenges last quarter. Have those abated any?
spk02: Yeah, so a lot of times when we get into these questions on relative feel of whether they be supply chain or logistical concerns, it's a bit like the frog in the boiling water. So any answer we give you is going to be relative to recency bias. So certainly, as Ken alluded to, some of the pressures we've felt feel like they were easing in Q4, but that's relative to the peak and not necessarily relative to normal. So while easing sequentially, we're not back to normal, nor do we expect either supply chain whether that's component availability or logistics, to be all of a sudden magically back to normal anytime soon in 2022. While we do think there's some easing of those pressures as the calendar progresses, they're not going away anytime soon.
spk01: Sure. Okay. I understand. I'll pass it along. Thank you.
spk06: Our next question comes from Tate Sullivan of Maximum Group. Kate, your line is open. Please go ahead with your question.
spk05: Thank you all. Focusing on the water quality monitoring details that you gave earlier in slide five, you mentioned some time and investment for the opportunity. Can you expand on that a little bit? Is it expanding the capacity, product introductions? You mentioned possibly for more acquisitions, but can you elaborate a bit further if you can?
spk07: So the investments are primarily twofold. So one is in aligning and training and getting synergy throughout the sales force, which we're well down the path on that. And then the second piece is bringing all of the excellent data that we get from the instrument sales and water quality up to 60 different water quality parameters, getting that, investing in The ability to bring that through our cellular communications and back through software to further enhance the value for end users is where the primary investment is. We're working on that already. Sometimes in the water industry, as we've talked about many times, it moves somewhat slowly, but in our model, we're going to continue to build out software, and we'll see that play out over the next couple of years.
spk05: Related to that and the water meter business, is it fair to say there will be more of a technology component to the water quality monitoring business than water meters?
spk07: Yeah, absolutely. I mean, the trend that we saw and why we were so excited about SCAN and ATI and what continues to be reinforced is this on-demand, real-time, from anywhere information for water quality which is really part of the AMI revolution in metering. So we feel like we got in at the right time with the right product offerings to really take advantage of that.
spk05: And maybe it's unfair comparing to your water meter business, but is the water quality opportunity more global at this point than the water meter business based on the different dynamics in the country, different countries for the water meters?
spk07: Well, you know, the thing about water quality and what's so great about it is everybody in the world is affected by it. So it certainly has tremendous global growth opportunities. If you recall, when we bought ATI and Ascan, these are both companies, proven technologies existed, both of them for more than 20 years, with an installed base of equipment in more than 50 countries. So albeit small companies, they have a really wide reach that has been really helpful, as I pointed out, already leveraging some relationships in the UK where Badger Meter hasn't necessarily been strong, but ATI has tremendous loyal relationships with the utilities there. So definitely we're excited about our global growth opportunities for both product lines, but water quality for sure has great global opportunities. Thank you.
spk06: Thank you. As a reminder, if you would like to ask a question, please press star followed by one in a telephone keypad. We currently have no further questions registered at this time, so I'll hand back over to the management team. Thank you.
spk00: Thank you all for joining our call today. For your planning purposes, our first quarter 2022 call is tentatively scheduled for April 19th. I'll be around all day to take any follow-up questions you might have. Have a great day and a great weekend.
spk06: Thank you very much for joining us today, ladies and gentlemen. You may now disconnect your lines. This concludes
Disclaimer